CHAPTER 8 STOCK VALUATION

Save this PDF as:
 WORD  PNG  TXT  JPG

Size: px
Start display at page:

Download "CHAPTER 8 STOCK VALUATION"

Transcription

1 CHAPTER 8 STOCK VALUATION Answers to Concepts Review and Critical Thinking Questions 5. The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred. However, the preferred is less risky because of the dividend and liquidation preference, so it is possible the preferred could be worth more, depending on the circumstances. 7. Yes. If the dividend grows at a steady rate, so does the stock price. In other words, the dividend growth rate and the capital gains yield are the same. 11. Presumably, the current stock value reflects the risk, timing and magnitude of all future cash flows, both short-term and long-term. If this is correct, then the statement is false. Solutions to Questions and Problems 1. The constant dividend growth model is: P t = D t (1 + g) / (R g) So the price of the stock today is: P 0 = D 0 (1 + g) / (R g) P 0 = $1.95 (1.04) / ( ) P 0 = $31.20 The dividend at Year 4 is the dividend today times the FVIF for the growth rate in dividends and four years, so: P 3 = D 3 (1 + g) / (R g) P 3 = D 0 (1 + g) 4 / (R g) P 3 = $1.95 (1.04) 4 / ( ) P 3 = $35.10 We can do the same thing to find the dividend in Year 16, which gives us the price in Year 15, so: P 15 = D 15 (1 + g) / (R g) P 15 = D 0 (1 + g) 16 / (R g) P 15 = $1.95 (1.04) 16 / ( ) P 15 = $56.19 There is another feature of the constant dividend growth model: The stock price grows at the dividend growth rate. So, if we know the stock price today, we can find the future value for any time in the future we want to calculate the stock price. In this problem, we want to know the stock price in

2 three years, and we have already calculated the stock price today. The stock price in three years will be: P 3 = P 0 (1 + g) 3 P 3 = $31.20(1 +.04) 3 P 3 = $35.10 And the stock price in 15 years will be: P 15 = P 0 (1 + g) 15 P 15 = $31.20(1 +.04) 15 P 15 = $ We need to find the required return of the stock. Using the constant growth model, we can solve the equation for R. Doing so, we find: R = (D 1 / P 0 ) + g R = ($2.04 / $37) R =.1001, or 10.01% 3. The dividend yield is the dividend next year divided by the current price, so the dividend yield is: Dividend yield = D 1 / P 0 Dividend yield = $2.04 / $37 Dividend yield =.0551, or 5.51% The capital gains yield, or percentage increase in the stock price, is the same as the dividend growth rate, so: Capital gains yield = 4.5% 5. The required return of a stock is made up of two parts: The dividend yield and the capital gains yield. So, the required return of this stock is: R = Dividend yield + Capital gains yield R = R =.0980, or 9.80% 8. The price of a share of preferred stock is the dividend divided by the required return. This is the same equation as the constant growth model, with a dividend growth rate of zero percent. Remember, most preferred stock pays a fixed dividend, so the growth rate is zero. Using this equation, we find the price per share of the preferred stock is: R = D / P 0 R = $3.50 / $85 R =.0412, or 4.12%

3 15. Here we have a stock that pays no dividends for 10 years. Once the stock begins paying dividends, it will have a constant growth rate of dividends. We can use the constant growth model at that point. It is important to remember that general constant dividend growth formula is: P t = [D t (1 + g)] / (R g) This means that since we will use the dividend in Year 10, we will be finding the stock price in Year 9. The dividend growth model is similar to the PVA and the PV of a perpetuity: The equation gives you the PV one period before the first payment. So, the price of the stock in Year 9 will be: P 9 = D 10 / (R g) P 9 = $14 / ( ) P 9 = $ The price of the stock today is simply the PV of the stock price in the future. We simply discount the future stock price at the required return. The price of the stock today will be: P 0 = $ / P 0 = $ With supernormal dividends, we find the price of the stock when the dividends level off at a constant growth rate, and then find the PV of the future stock price, plus the PV of all dividends during the supernormal growth period. The stock begins constant growth in Year 4, so we can find the price of the stock in Year 4, at the beginning of the constant dividend growth, as: P 4 = D 4 (1 + g) / (R g) P 4 = $2.75(1.05) / (.12.05) P 4 = $41.25 The price of the stock today is the PV of the first four dividends, plus the PV of the Year 4 stock price. So, the price of the stock today will be: P 0 = $13 / $9 / $6 / $2.75 / $41.25 / P 0 = $ With supernormal dividends, we find the price of the stock when the dividends level off at a constant growth rate, and then find the PV of the future stock price, plus the PV of all dividends during the supernormal growth period. The stock begins constant growth in Year 4, so we can find the price of the stock in Year 3, one year before the constant dividend growth begins as: P 3 = D 3 (1 + g) / (R g) P 3 = D 0 (1 + g 1 ) 3 (1 + g 2 ) / (R g) P 3 = $2.15(1.30) 3 (1.04) / (.11.04) P 3 = $70.18 The price of the stock today is the PV of the first three dividends, plus the PV of the Year 3 stock price. The price of the stock today will be: P 0 = $2.15(1.30) / $2.15(1.30) 2 / $2.15(1.30) 3 / $70.18 / P 0 = $60.23

4 We could also use the two-stage dividend growth model for this problem, which is: P 0 = [D 0 (1 + g 1 )/(R g 1 )]{1 [(1 + g 1 )/(1 + R)] t }+ [(1 + g 1 )/(1 + R)] t [D 0 (1 + g 2 )/(R g 2 )] P 0 = [$2.15(1.30)/(.11.30)][1 (1.30/1.11) 3 ] + [(1 +.30)/(1 +.11)] 3 [$2.15(1.04)/(.11.04)] P 0 = $ Here we need to find the dividend next year for a stock experiencing supernormal growth. We know the stock price, the dividend growth rates, and the required return, but not the dividend. First, we need to realize that the dividend in Year 3 is the current dividend times the FVIF. The dividend in Year 3 will be: D 3 = D 0 (1.30) 3 And the dividend in Year 4 will be the dividend in Year 3 times one plus the growth rate, or: D 4 = D 0 (1.30) 3 (1.20) The stock begins constant growth in Year 4, so we can find the price of the stock in Year 4 as the dividend in Year 5, divided by the required return minus the growth rate. The equation for the price of the stock in Year 4 is: P 4 = D 4 (1 + g) / (R g) Now we can substitute the previous dividend in Year 4 into this equation as follows: P 4 = D 0 (1 + g 1 ) 3 (1 + g 2 ) (1 + g 3 ) / (R g) P 4 = D 0 (1.30) 3 (1.20) (1.06) / (.10.06) P 4 = 69.86D 0 When we solve this equation, we find that the stock price in Year 4 is times as large as the dividend today. Now we need to find the equation for the stock price today. The stock price today is the PV of the dividends in Years 1, 2, 3, and 4, plus the PV of the Year 4 price. So: P 0 = D 0 (1.30)/ D 0 (1.30) 2 / D 0 (1.30) 3 / D 0 (1.30) 3 (1.20)/ D 0 / We can factor out D 0 in the equation and combine the last two terms. Doing so, we get: P 0 = $86 = D 0 {1.30/ / / [(1.30) 3 (1.20) ] / } Reducing the equation even further by solving all of the terms in the braces, we get: $86 = $53.75D 0 D 0 = $86 / $53.75 D 0 = $1.60 This is the dividend today, so the projected dividend for the next year will be: D 1 = $1.60(1.30) D 1 = $2.08

5 20. The constant growth model can be applied even if the dividends are declining by a constant percentage, just make sure to recognize the negative growth. So, the price of the stock today will be: P 0 = D 0 (1 + g) / (R g) P 0 = $10.25(1.03) / [(.095 (.03)] P 0 = $ We are given the stock price, the dividend growth rate, and the required return and are asked to find the dividend. Using the constant dividend growth model, we get: P 0 = $68 = D 0 (1 + g) / (R g) Solving this equation for the dividend gives us: D 0 = $68( ) / (1.0375) D 0 = $ The price of a share of preferred stock is the dividend payment divided by the required return. We know the dividend payment in Year 20, so we can find the price of the stock in Year 19, one year before the first dividend payment. Doing so, we get: P 19 = $20.00 /.0535 P 19 = $ The price of the stock today is the PV of the stock price in the future, so the price today will be: P 0 = $ / (1.0535) 19 P 0 = $ We can use the two-stage dividend growth model for this problem, which is: P 0 = [D 0 (1 + g 1 )/(R g 1 )]{1 [(1 + g 1 )/(1 + R)] t }+ [(1 + g 1 )/(1 + R)] t [D 0 (1 + g 2 )/(R g 2 )] P 0 = [$1.55(1.27)/(.12.27)][1 (1.27/1.12) 8 ] + [(1.27)/(1.12)] 8 [$1.55(1.035)/( )] P 0 = $ We can use the two-stage dividend growth model for this problem, which is: P 0 = [D 0 (1 + g 1 )/(R g 1 )]{1 [(1 + g 1 )/(1 + R)] t }+ [(1 + g 1 )/(1 + R)] t [D 0 (1 + g 2 )/(R g 2 )] P 0 = [$1.94(1.16)/(.10.16)][1 (1.16/1.10) 11 ] + [(1.16)/(1.10)] 11 [$1.94(1.04)/(.10.04)] P 0 = $88.02

6 31. To find the target stock price, we first need to calculate the growth rate in earnings. We can use the sustainable growth rate from a previous chapter. First, the ROE is: ROE = Net income / Equity ROE = $875,000 / $7,300,000 ROE =.1199, or 11.99% We also need the retention ratio, which is one minus the payout ratio, or: b = 1 Dividends / Net income b = 1 $345,000 / $875,000 b =.6057, or 60.57% So, the sustainable growth rate is: Sustainable growth rate = (ROE b) / (1 ROE b) Sustainable growth rate = ( ) / ( ) Sustainable growth rate =.0783, or 7.83% Now we need to find the current EPS, which is: EPS 0 = Net income / Shares outstanding EPS 0 = $875,000 / 125,000 EPS 0 = $7.00 So, the EPS next year will be: EPS 1 = EPS 0 (1 + g) EPS 1 = $7.00( ) EPS 1 = $7.55 Finally, the target share price next year is: P 1 = Benchmark PE ratio EPS 5 P 1 = 16($7.55) P 1 = $120.77

7 32. We are asked to find the dividend yield and capital gains yield for each of the stocks. All of the stocks have a required return of 15 percent, which is the sum of the dividend yield and the capital gains yield. To find the components of the total return, we need to find the stock price for each stock. Using this stock price and the dividend, we can calculate the dividend yield. The capital gains yield for the stock will be the total return (required return) minus the dividend yield. W: P 0 = D 0 (1 + g) / (R g) = $3.75(1.10) / (.15.10) = $82.50 Dividend yield = D 1 / P 0 = $3.75(1.10) / $82.50 =.05, or 5% Capital gains yield = =.10, or 10% X: P 0 = D 0 (1 + g) / (R g) = $3.75 / (.15 0) = $25.00 Dividend yield = D 1 / P 0 = $3.75 / $25.00 =.15, or 15% Capital gains yield = = 0% Y: P 0 = D 0 (1 + g) / (R g) = $3.75(1.05) / ( ) = $17.81 Dividend yield = D 1 / P 0 = $3.75(.95) / $17.81 =.20, or 20% Capital gains yield = =.05, or 5% Z: P 2 = D 2 (1 + g) / (R g) = D 0 (1 + g 1 ) 2 (1 + g 2 ) / (R g 2 ) P 2 = $3.75(1.20) 2 (1.05) / (.15.05) = $56.70 P 0 = $3.75 (1.20) / (1.15) + $3.75 (1.20) 2 / (1.15) 2 + $56.70 / (1.15) 2 = $50.87 Dividend yield = D 1 / P 0 = $3.75(1.20) / $50.87 =.088, or 8.8% Capital gains yield = =.062, or 6.2% In all cases, the return is 15 percent, but the return is distributed differently between current income and capital gains. High growth stocks have an appreciable capital gains component but a relatively small current income yield; conversely, mature, negative-growth stocks provide a high current income but also price depreciation over time.

CHAPTER 5 HOW TO VALUE STOCKS AND BONDS

CHAPTER 5 HOW TO VALUE STOCKS AND BONDS CHAPTER 5 HOW TO VALUE STOCKS AND BONDS Answers to Concepts Review and Critical Thinking Questions 1. Bond issuers look at outstanding bonds of similar maturity and risk. The yields on such bonds are used

More information

Key Concepts and Skills Chapter 8 Stock Valuation

Key Concepts and Skills Chapter 8 Stock Valuation Key Concepts and Skills Chapter 8 Stock Valuation Konan Chan Financial Management, Spring 2016 Understand how stock prices depend on future dividends and dividend growth Be able to compute stock prices

More information

CHAPTER 8 INTEREST RATES AND BOND VALUATION

CHAPTER 8 INTEREST RATES AND BOND VALUATION CHAPTER 8 INTEREST RATES AND BOND VALUATION Solutions to Questions and Problems 1. The price of a pure discount (zero coupon) bond is the present value of the par value. Remember, even though there are

More information

Primary Market - Place where the sale of new stock first occurs. Initial Public Offering (IPO) - First offering of stock to the general public.

Primary Market - Place where the sale of new stock first occurs. Initial Public Offering (IPO) - First offering of stock to the general public. Stock Valuation Primary Market - Place where the sale of new stock first occurs. Initial Public Offering (IPO) - First offering of stock to the general public. Seasoned Issue - Sale of new shares by a

More information

Stock valuation. Price of a First period's dividends Second period's dividends Third period's dividends = + + +... share of stock

Stock valuation. Price of a First period's dividends Second period's dividends Third period's dividends = + + +... share of stock Stock valuation A reading prepared by Pamela Peterson Drake O U T L I N E. Valuation of common stock. Returns on stock. Summary. Valuation of common stock "[A] stock is worth the present value of all the

More information

CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH

CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH Answers to Concepts Review and Critical Thinking Questions 5. The sustainable growth rate is greater than 20 percent, because at a 20 percent growth rate

More information

TIP If you do not understand something,

TIP If you do not understand something, Valuing common stocks Application of the DCF approach TIP If you do not understand something, ask me! The plan of the lecture Review what we have accomplished in the last lecture Some terms about stocks

More information

Bond Valuation. What is a bond?

Bond Valuation. What is a bond? Lecture: III 1 What is a bond? Bond Valuation When a corporation wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities called bonds. A bond

More information

LECTURE- 4. Valuing stocks Berk, De Marzo Chapter 9

LECTURE- 4. Valuing stocks Berk, De Marzo Chapter 9 1 LECTURE- 4 Valuing stocks Berk, De Marzo Chapter 9 2 The Dividend Discount Model A One-Year Investor Potential Cash Flows Dividend Sale of Stock Timeline for One-Year Investor Since the cash flows are

More information

Dividend valuation models Prepared by Pamela Peterson Drake, Ph.D., CFA

Dividend valuation models Prepared by Pamela Peterson Drake, Ph.D., CFA Dividend valuation models Prepared by Pamela Peterson Drake, Ph.D., CFA Contents 1. Overview... 1 2. The basic model... 1 3. Non-constant growth in dividends... 5 A. Two-stage dividend growth... 5 B. Three-stage

More information

CHAPTER 14 COST OF CAPITAL

CHAPTER 14 COST OF CAPITAL CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,

More information

Review for Exam 3. Instructions: Please read carefully

Review for Exam 3. Instructions: Please read carefully Review for Exam 3 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems. You are not responsible for any topics that are not covered in the lecture note

More information

What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated?

What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated? What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? HOCK international - 2004 1 HOCK international - 2004 2 How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated? HOCK

More information

You just paid $350,000 for a policy that will pay you and your heirs $12,000 a year forever. What rate of return are you earning on this policy?

You just paid $350,000 for a policy that will pay you and your heirs $12,000 a year forever. What rate of return are you earning on this policy? 1 You estimate that you will have $24,500 in student loans by the time you graduate. The interest rate is 6.5%. If you want to have this debt paid in full within five years, how much must you pay each

More information

FINC 3630: Advanced Business Finance Additional Practice Problems

FINC 3630: Advanced Business Finance Additional Practice Problems FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal year-ended February 1, 2015 (the 2014 fiscal

More information

FSA Note: Summary of Financial Ratio Calculations

FSA Note: Summary of Financial Ratio Calculations FSA Note: Summary of Financial Ratio Calculations This note contains a summary of the more common financial statement ratios. A few points should be noted: Calculations vary in practice; consistency and

More information

Chapter 17: Financial Statement Analysis

Chapter 17: Financial Statement Analysis FIN 301 Class Notes Chapter 17: Financial Statement Analysis INTRODUCTION Financial ratio: is a relationship between different accounting items that tells something about the firm s activities. Purpose

More information

Goals. Stock Valuation. Dividend Discount Model Constant Dividends. Dividend Discount Model Constant Dividends

Goals. Stock Valuation. Dividend Discount Model Constant Dividends. Dividend Discount Model Constant Dividends Stock Valuation Economics 71a: Spring 2007 Mayo 11 Malkiel, 5, 6 (136-144), 8 Lecture notes 4.2 Goals Dividend valuation model dividend discount model Forecasting earnings, dividends, and prices Ratio

More information

Chapter 3 Analyzing Financial Statement

Chapter 3 Analyzing Financial Statement Chapter 3 Analyzing Financial Statement Five major areas to analyze. (1) Liquidity Position (2) Management of Assets (3) Management of Debt (4) Company's Profitability (5) Market's View of Company (1)

More information

Features of Common Stock. The Stock Markets. Features of Preferred Stock. Valuation of Securities: Stocks

Features of Common Stock. The Stock Markets. Features of Preferred Stock. Valuation of Securities: Stocks Valuation of Securities: Stocks Econ 422: Investment, Capital & Finance University of Washington Eric Zivot Fall 27 January 31, 27 Features of Common Stock Voting rights (Cumulative vs. Straight) Proxy

More information

Equity Analysis and Capital Structure. A New Venture s Perspective

Equity Analysis and Capital Structure. A New Venture s Perspective Equity Analysis and Capital Structure A New Venture s Perspective 1 Venture s Capital Structure ASSETS Short- term Assets Cash A/R Inventories Long- term Assets Plant and Equipment Intellectual Property

More information

Module 8 Investing in stocks

Module 8 Investing in stocks 1. Overview Module 8 Investing in stocks Prepared by Pamela Peterson Drake, Ph.D., CFA When an investor buys a share of common stock, it is reasonable to expect that what an investor is willing to pay

More information

Chapter 6. Learning Objectives Principles Used in This Chapter 1. Annuities 2. Perpetuities 3. Complex Cash Flow Streams

Chapter 6. Learning Objectives Principles Used in This Chapter 1. Annuities 2. Perpetuities 3. Complex Cash Flow Streams Chapter 6 Learning Objectives Principles Used in This Chapter 1. Annuities 2. Perpetuities 3. Complex Cash Flow Streams 1. Distinguish between an ordinary annuity and an annuity due, and calculate present

More information

ISS Governance Services Proxy Research. Company Financials Compustat Data Definitions

ISS Governance Services Proxy Research. Company Financials Compustat Data Definitions ISS Governance Services Proxy Research Company Financials Compustat Data Definitions June, 2008 TABLE OF CONTENTS Data Page Overview 3 Stock Snapshot 1. Closing Price 3 2. Common Shares Outstanding 3 3.

More information

CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH

CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH Answers to Concepts Review and Critical Thinking Questions 1. Time trend analysis gives a picture of changes in the company s financial situation over

More information

Review for Exam 3. Instructions: Please read carefully

Review for Exam 3. Instructions: Please read carefully Review for Exam 3 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation

More information

NWC = current assets - current liabilities = 2,100

NWC = current assets - current liabilities = 2,100 Questions and Problems Chapters 2,3 pp45-47 1. Building a balance sheet. Penguin Pucks, Inc., has current assets of $3,000, net fixed assets $6,000, current liabilities of $900, and long-term debt of $5,000.

More information

Portfolio Characteristic Definitions

Portfolio Characteristic Definitions ANALYTICAL SOLUTIONS GROUP PEP Portfolio Characteristic Definitions EQUITY PORTFOLIO CHARACTERISTICS All portfolio characteristics are derived by first calculating the characteristics for each security,

More information

Bank Valuation: Comparable Public Companies & Precedent Transactions

Bank Valuation: Comparable Public Companies & Precedent Transactions Bank Valuation: Comparable Public Companies & Precedent Transactions Picking a set of comparable companies or precedent transactions for a bank is very similar to what you d do for any other company here

More information

CHAPTER 9 Time Value Analysis

CHAPTER 9 Time Value Analysis Copyright 2008 by the Foundation of the American College of Healthcare Executives 6/11/07 Version 9-1 CHAPTER 9 Time Value Analysis Future and present values Lump sums Annuities Uneven cash flow streams

More information

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Chapter 3 Interpreting Financial Ratios Concept Check 3.1 1. What are the different motivations that

More information

Cash Flow Analysis Venture Business Perspective

Cash Flow Analysis Venture Business Perspective Cash Flow Analysis Venture Business Perspective Cash Flow (CF) Analysis What is CF and how is determined? CF Free CF Managing CF Cash Conversion Cyclical CF Break-even Valuing venture businesses based

More information

Unit 01. 1. Return computation with cash purchase vs. margin purchase

Unit 01. 1. Return computation with cash purchase vs. margin purchase FCS 5510 Formula Sheet *Note: The formulas I expect you to know are colored in Red. They are either more conceptually based, or are more commonly used than the others. You need to have a passing familiarity

More information

Investment Analysis (FIN 670) Fall Homework 8

Investment Analysis (FIN 670) Fall Homework 8 Investment Analysis (FIN 67) Fall 29 Homework 8 Instructions: please read carefully You should show your work how to get the answer for each calculation question to get full credit The due date is Tue

More information

Chapter 8. Stock Valuation Process. Stock Valuation

Chapter 8. Stock Valuation Process. Stock Valuation Stock Valuation Process Chapter 8 Stock Valuation: Investors use risk and return concept to determine the worth of a security. In the valuation process: The intrinsic value of any investment equals the

More information

Principles of Corporate Finance. Chapter 4. The Value of Common Stocks. Seventh Edition. Richard A. Brealey Stewart C. Myers. Slides by Matthew Will

Principles of Corporate Finance. Chapter 4. The Value of Common Stocks. Seventh Edition. Richard A. Brealey Stewart C. Myers. Slides by Matthew Will Principles of Corporate Finance Chapter 4 The Value of Common Stocks Seventh Edition Richard A. Brealey Stewart C. Myers Slides by Matthew Will - 2 Topics Covered How Common Stocks are Traded How To Value

More information

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2 DUKE UNIVERSITY Fuqua School of Business FINANCE 351 - CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Hors d Age Cheeseworks has been paying a regular cash dividend

More information

2. How would (a) a decrease in the interest rate or (b) an increase in the holding period of a deposit affect its future value? Why?

2. How would (a) a decrease in the interest rate or (b) an increase in the holding period of a deposit affect its future value? Why? CHAPTER 3 CONCEPT REVIEW QUESTIONS 1. Will a deposit made into an account paying compound interest (assuming compounding occurs once per year) yield a higher future value after one period than an equal-sized

More information

Ratio Analysis CBDC, NB. Presented by ACSBE. February, 2008. Copyright 2007 ACSBE. All Rights Reserved.

Ratio Analysis CBDC, NB. Presented by ACSBE. February, 2008. Copyright 2007 ACSBE. All Rights Reserved. Ratio Analysis CBDC, NB February, 2008 Presented by ACSBE Financial Analysis What is Financial Analysis? What Can Financial Ratios Tell? 7 Categories of Financial Ratios Significance of Using Ratios Industry

More information

Modified dividend payout ratio =

Modified dividend payout ratio = 15 Modifying the model to include stock buybacks In recent years, firms in the United States have increasingly turned to stock buybacks as a way of returning cash to stockholders. Figure 13.3 presents

More information

CHAPTER 2 INTRODUCTION TO CORPORATE FINANCE

CHAPTER 2 INTRODUCTION TO CORPORATE FINANCE CHAPTER 2 INTRODUCTION TO CORPORATE FINANCE Solutions to Questions and Problems NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and

More information

CHAPTER 8 INTEREST RATES AND BOND VALUATION

CHAPTER 8 INTEREST RATES AND BOND VALUATION CHAPTER 8 INTEREST RATES AND BOND VALUATION Answers to Concept Questions 1. No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury securities have substantial

More information

Learning Objective: Compare the financial implications of the different forms of business organizations. Learning Objective: Compare the

Learning Objective: Compare the financial implications of the different forms of business organizations. Learning Objective: Compare the 1. award: MC Qu. 6 Todd and Cathy created a firm that is... Todd and Cathy created a firm that is a separate legal entity and will share ownership of that firm on a 50 50 basis. Which type of entity did

More information

Financial Formulas. 5/2000 Chapter 3 Financial Formulas i

Financial Formulas. 5/2000 Chapter 3 Financial Formulas i Financial Formulas 3 Financial Formulas i In this chapter 1 Formulas Used in Financial Calculations 1 Statements of Changes in Financial Position (Total $) 1 Cash Flow ($ millions) 1 Statements of Changes

More information

CHAPTER 22: FUTURES MARKETS

CHAPTER 22: FUTURES MARKETS CHAPTER 22: FUTURES MARKETS PROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support

More information

Finance 3130 Corporate Finiance Sample Final Exam Spring 2012

Finance 3130 Corporate Finiance Sample Final Exam Spring 2012 Finance 3130 Corporate Finiance Sample Final Exam Spring 2012 True/False Indicate whether the statement is true or falsewith A for true and B for false. 1. Interest paid by a corporation is a tax deduction

More information

MBA Financial Management and Markets Exam 1 Spring 2009

MBA Financial Management and Markets Exam 1 Spring 2009 MBA Financial Management and Markets Exam 1 Spring 2009 The following questions are designed to test your knowledge of the fundamental concepts of financial management structure [chapter 1], financial

More information

Module 1: Corporate Finance and the Role of Venture Capital Financing TABLE OF CONTENTS

Module 1: Corporate Finance and the Role of Venture Capital Financing TABLE OF CONTENTS 1.0 ALTERNATIVE SOURCES OF FINANCE Module 1: Corporate Finance and the Role of Venture Capital Financing Alternative Sources of Finance TABLE OF CONTENTS 1.1 Short-Term Debt (Short-Term Loans, Line of

More information

Chapter 7 Stocks, Stock Valuation, and Stock Market Equilibrium ANSWERS TO END-OF-CHAPTER QUESTIONS

Chapter 7 Stocks, Stock Valuation, and Stock Market Equilibrium ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 7 Stocks, Stock Valuation, and Stock Market Equilibrium ANSWERS TO END-OF-CHAPTER QUESTIONS 7-1 a. A proxy is a document giving one person the authority to act for another, typically the power

More information

Financial Condition Analysis Model

Financial Condition Analysis Model Financial Condition Analysis Model GOVERNMENTAL ACTIVITIES & ENTERPRISE FUNDS Economic resources and accrual basis of accounting Flow Financial Dimension Financial Indicator Interpretation Interperiod

More information

6-2. The substantive growth rate refers to dividend growth that can be sustained by a company's earnings. A) True B) False

6-2. The substantive growth rate refers to dividend growth that can be sustained by a company's earnings. A) True B) False Investments 320 Dr. Ahmed Y. Dashti Interactive Qustions Chapter 6 6-1. Due to its simplicity, the constant perpetual growth model can be usefully applied to any company. A) True B) False 6-2. The substantive

More information

Homework Solutions - Lecture 4

Homework Solutions - Lecture 4 Homework Solutions - Lecture 4 1. Estimate fundamental growth in EBIT for Nike based on the firm s reinvestment rate and ROC in the most recent year. Be sure to incorporate any necessary adjustments made

More information

FNCE 301, Financial Management H Guy Williams, 2006

FNCE 301, Financial Management H Guy Williams, 2006 Stock Valuation Stock characteristics Stocks are the other major traded security (stocks & bonds). Options are another traded security but not as big as these two. - Ownership Stockholders are the owner

More information

TYPES OF FINANCIAL RATIOS

TYPES OF FINANCIAL RATIOS TYPES OF FINANCIAL RATIOS In the previous articles we discussed how to invest in the stock market and unit trusts. When investing in the stock market an investor should have a clear understanding about

More information

Chapter 6 Contents. Principles Used in Chapter 6 Principle 1: Money Has a Time Value.

Chapter 6 Contents. Principles Used in Chapter 6 Principle 1: Money Has a Time Value. Chapter 6 The Time Value of Money: Annuities and Other Topics Chapter 6 Contents Learning Objectives 1. Distinguish between an ordinary annuity and an annuity due, and calculate present and future values

More information

2. The spreadsheet implementation of the three transformations

2. The spreadsheet implementation of the three transformations Valuation: Dividends, Book Values, and Earnings 1 1. Overview VALUATION: DIVIDENDS, BOOK VALUES, AND EARNINGS Dan Gode and James Ohlson Dividends, book values, and earnings are the three widely used financial

More information

Corporate Finance: Final Exam

Corporate Finance: Final Exam Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. For partial credit, when discounting, please show the discount rate

More information

Finance 3130 Sample Exam 1B Spring 2012

Finance 3130 Sample Exam 1B Spring 2012 Finance 3130 Sample Exam 1B Spring 2012 True/False Indicate whether the statement is true or false. 1. A firm s income statement provides information as of a point in time, and represents how management

More information

Often stock is split to lower the price per share so it is more accessible to investors. The stock split is not taxable.

Often stock is split to lower the price per share so it is more accessible to investors. The stock split is not taxable. Reading: Chapter 8 Chapter 8. Stock: Introduction 1. Rights of stockholders 2. Cash dividends 3. Stock dividends 4. The stock split 5. Stock repurchases and liquidations 6. Preferred stock 7. Analysis

More information

Current Ratio: Current Assets / Current Liabilities. Measure of whether company has enough cash to cover immediate expenses

Current Ratio: Current Assets / Current Liabilities. Measure of whether company has enough cash to cover immediate expenses 1 Beta: a measure of a stock s volatility relative to the overall market (typically the S&P500 index is used as a proxy for the overall market ). The higher the beta, the more volatile the stock price.

More information

Stock Valuation. Chapter Organization. Common Stock Valuation. Common Stock Features. Preferred Stock Features. Stock Market Reporting

Stock Valuation. Chapter Organization. Common Stock Valuation. Common Stock Features. Preferred Stock Features. Stock Market Reporting Chapter Outline Stock Valuation Chapter Organization Common Stock Valuation Common Stock Features Preferred Stock Features Stock Market Reporting Summary and Conclusions Common Stock Cash Flows and the

More information

6. Debt Valuation and the Cost of Capital

6. Debt Valuation and the Cost of Capital 6. Debt Valuation and the Cost of Capital Introduction Firms rarely finance capital projects by equity alone. They utilise long and short term funds from a variety of sources at a variety of costs. No

More information

Chapter 7. . 1. component of the convertible can be estimated as 1100-796.15 = 303.85.

Chapter 7. . 1. component of the convertible can be estimated as 1100-796.15 = 303.85. Chapter 7 7-1 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders

More information

Accounting Income, Residual Income and Valuation

Accounting Income, Residual Income and Valuation Accounting Income, Residual Income and Valuation Ray Donnelly PhD, MSc, BComm, ACMA Examiner in Strategic Corporate Finance 1. Introduction The residual income (RI) for a firm for any year t is its accounting

More information

NIKE Case Study. Professor Corwin. An overview of the individual questions and their relation to the lecture topics is provided below.

NIKE Case Study. Professor Corwin. An overview of the individual questions and their relation to the lecture topics is provided below. NIKE Case Study Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the most important

More information

CHAPTER 5. Interest Rates. Chapter Synopsis

CHAPTER 5. Interest Rates. Chapter Synopsis CHAPTER 5 Interest Rates Chapter Synopsis 5.1 Interest Rate Quotes and Adjustments Interest rates can compound more than once per year, such as monthly or semiannually. An annual percentage rate (APR)

More information

M.I.T. Spring 1999 Sloan School of Management 15.415. First Half Summary

M.I.T. Spring 1999 Sloan School of Management 15.415. First Half Summary M.I.T. Spring 1999 Sloan School of Management 15.415 First Half Summary Present Values Basic Idea: We should discount future cash flows. The appropriate discount rate is the opportunity cost of capital.

More information

Return on Equity has three ratio components. The three ratios that make up Return on Equity are:

Return on Equity has three ratio components. The three ratios that make up Return on Equity are: Evaluating Financial Performance Chapter 1 Return on Equity Why Use Ratios? It has been said that you must measure what you expect to manage and accomplish. Without measurement, you have no reference to

More information

Q3: What is the quarterly equivalent of a continuous rate of 3%?

Q3: What is the quarterly equivalent of a continuous rate of 3%? SESSION 1: Pre-requisites: a reminder Time value of money, annuities Q1: You wish to buy a new house but would need to borrow part of the required amount. In view of your revenues you have been able to

More information

Chapter Review and Self-Test Problems

Chapter Review and Self-Test Problems CHAPTER 8 Stock Valuation 265 2. As the owner of shares of common stock in a corporation, you have various rights, including the right to vote to elect corporate directors. Voting in corporate elections

More information

Discounted Cash Flow Valuation

Discounted Cash Flow Valuation 6 Formulas Discounted Cash Flow Valuation McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Outline Future and Present Values of Multiple Cash Flows Valuing

More information

What accounting students should know about the price-earnings ratio

What accounting students should know about the price-earnings ratio ABSTRACT What accounting students should know about the price-earnings ratio Dean W. DiGregorio Southeastern Louisiana University The price-earnings ratio (P/E ratio) is a valuation multiple that can be

More information

CAPITALIZATION/DISCOUNT

CAPITALIZATION/DISCOUNT Fundamentals, Techniques & Theory CAPITALIZATION/DISCOUNT RATES CHAPTER FIVE CAPITALIZATION/DISCOUNT RATES I. OVERVIEW Money doesn t always bring happiness People with ten million dollars are no happier

More information

Certified Financial Management Professional VS-1201

Certified Financial Management Professional VS-1201 Certified Financial Management Professional VS-1201 Certified Financial Management Professional Certified Financial Management Professional Certification Code VS-1201 Vskills certification for Financial

More information

Chapter 02 How to Calculate Present Values

Chapter 02 How to Calculate Present Values Chapter 02 How to Calculate Present Values Multiple Choice Questions 1. The present value of $100 expected in two years from today at a discount rate of 6% is: A. $116.64 B. $108.00 C. $100.00 D. $89.00

More information

Equity and Fixed Income

Equity and Fixed Income Equity and Fixed Income Juliusz Jabłecki Quantitative Finance Dept. Faculty of Economic Sciences University of Warsaw jjablecki@wne.uw.edu.pl and Head of Monetary Policy Analysis Team Economic Institute,

More information

Measuring Financial Performance: A Critical Key to Managing Risk

Measuring Financial Performance: A Critical Key to Managing Risk Measuring Financial Performance: A Critical Key to Managing Risk Dr. Laurence M. Crane Director of Education and Training National Crop Insurance Services, Inc. The essence of managing risk is making good

More information

Chapter 9 Valuing Stocks

Chapter 9 Valuing Stocks Chapter 9 Valuing Stocks 9-1. Assume Evco, Inc., has a current price of $50 and will pay a $2 dividend in one year, and its equity cost of capital is 15%. What price must you expect it to sell for right

More information

CHAPTER 7 INTEREST RATES AND BOND VALUATION

CHAPTER 7 INTEREST RATES AND BOND VALUATION CHAPTER 7 INTEREST RATES AND BOND VALUATION Answers to Concepts Review and Critical Thinking Questions 1. No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury

More information

Financial Ratio Cheatsheet MyAccountingCourse.com PDF

Financial Ratio Cheatsheet MyAccountingCourse.com PDF Financial Ratio Cheatsheet MyAccountingCourse.com PDF Table of contents Liquidity Ratios Solvency Ratios Efficiency Ratios Profitability Ratios Market Prospect Ratios Coverage Ratios CPA Exam Ratios to

More information

CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY

CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY Answers to Concepts Review and Critical Thinking Questions 1. The four parts are the present value (PV), the future value (FV), the discount

More information

Exam 1 Morning Session

Exam 1 Morning Session 91. A high yield bond fund states that through active management, the fund s return has outperformed an index of Treasury securities by 4% on average over the past five years. As a performance benchmark

More information

( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100

( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100 Mariusz Próchniak Chair of Economics II Warsaw School of Economics CAPITAL BUDGETING Managerial Economics 1 2 1 Future value (FV) r annual interest rate B the amount of money held today Interest is compounded

More information

The Time Value of Money

The Time Value of Money The Time Value of Money Future Value - Amount to which an investment will grow after earning interest. Compound Interest - Interest earned on interest. Simple Interest - Interest earned only on the original

More information

Ratios Formula Purpose/Use

Ratios Formula Purpose/Use Ratio Review: Formulas, Purpose & Use Word of Caution: Please remember that the significance of any particular ratio in the ratio analysis set is highly dependent upon the industry. For example, Gross

More information

12. What is the Internal Rate of Return for the project? a. 18.52 percent d. 21.79 percent b. 16.95 percent e. 15.55 percent c. 20.

12. What is the Internal Rate of Return for the project? a. 18.52 percent d. 21.79 percent b. 16.95 percent e. 15.55 percent c. 20. Business Finance Name Examination Four Spring 2005 version 4 Select the best answer for each of the following questions. Mark your selection on the examination and on your scantron. You may also record

More information

How to calculate present values

How to calculate present values How to calculate present values Back to the future Chapter 3 Discounted Cash Flow Analysis (Time Value of Money) Discounted Cash Flow (DCF) analysis is the foundation of valuation in corporate finance

More information

CHAPTER 2 FINANCIAL STATEMENTS AND CASH FLOW

CHAPTER 2 FINANCIAL STATEMENTS AND CASH FLOW CHAPTER 2 FINANCIAL STATEMENTS AND CASH FLOW Solutions to Questions and Problems NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and

More information

Financial-Institutions Management. Solutions 1. 6. A financial institution has the following market value balance sheet structure:

Financial-Institutions Management. Solutions 1. 6. A financial institution has the following market value balance sheet structure: FIN 683 Professor Robert Hauswald Financial-Institutions Management Kogod School of Business, AU Solutions 1 Chapter 7: Bank Risks - Interest Rate Risks 6. A financial institution has the following market

More information

Chapter 3 Unit 1. IET 35000 Engineering Economics. Learning Objectives Chapter 3. Learning Objectives Unit 1

Chapter 3 Unit 1. IET 35000 Engineering Economics. Learning Objectives Chapter 3. Learning Objectives Unit 1 Chapter 3 Unit 1 The Accounting Equation Depreciation, Inventory and Ratios IET 35000 Engineering Economics Learning Objectives Chapter 3 Upon completion of this chapter you should understand: Accounting

More information

CHAPTER 9 Stocks and Their Valuation

CHAPTER 9 Stocks and Their Valuation CHAPTER 9 Stocks and Their Valuation Preferred stock Features of common stock etermining common stock values Efficient markets 1 Preferred Stock Hybrid security. Similar to bonds in that preferred stockholders

More information

Unit Return computation with cash purchase vs. margin purchase

Unit Return computation with cash purchase vs. margin purchase FCS 5510 Formula Sheet *Note: The formulas I expect you to know are colored in Red. They are either more conceptually based, or are more commonly used than the others. You need to have a passing familiarity

More information

THE VALUATION OF A SAVINGS ACCOUNT

THE VALUATION OF A SAVINGS ACCOUNT THE VALUATION OF A SAVINGS ACCOUNT (With Seven Insights) A savings account is a simple investment that we all understand. We shall use it as a prototype for equity valuation. We shall use it to test ideas

More information

CHAPTER FOURTEEN. Simple Forecasting and Simple Valuation

CHAPTER FOURTEEN. Simple Forecasting and Simple Valuation CHAPTER FOURTEEN Simple Forecasting and Simple Valuation Concept Questions C14.1 Book values give a good forecast when they are reviewed at their fair value: applying the required return to book value

More information

BF 6701 : Financial Management Comprehensive Examination Guideline

BF 6701 : Financial Management Comprehensive Examination Guideline BF 6701 : Financial Management Comprehensive Examination Guideline 1) There will be 5 essay questions and 5 calculation questions to be completed in 1-hour exam. 2) The topics included in those essay and

More information

CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS

CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS 1 CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS (f) 1 The three step valuation process consists of 1) analysis of alternative economies and markets, 2) analysis of alternative industries

More information

Financial ratio analysis

Financial ratio analysis Financial ratio analysis A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction 2. Liquidity ratios 3. Profitability ratios and activity ratios 4. Financial leverage ratios 5. Shareholder

More information

An explanation of some basic concepts for Ratios and Analysis for Shares

An explanation of some basic concepts for Ratios and Analysis for Shares An explanation of some basic concepts for Ratios and Analysis for Shares NPAT or Net Profits After Tax Net Profit after Tax (NPAT) is one of the more important figures that a company makes public. NPAT

More information

Fundamental Analysis Ratios

Fundamental Analysis Ratios Fundamental Analysis Ratios Fundamental analysis ratios are used to both measure the performance of a company relative to other companies in the same market sector and to value a company. There are three

More information

Click Here to Buy the Tutorial

Click Here to Buy the Tutorial FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin-534/fin-534-week-4-quiz-3- str/ For more course tutorials visit www.tutorialoutlet.com Which of the following

More information